Founded in 1993 by brothers Tom and David Gardner, The Motley Fool helps millions of people attain financial freedom through our website, podcasts, books, newspaper column, radio show, and premium investing services.

Amazon’s Advertising Business Isn’t Its Achilles' Heel

The tech giant’s ad business could hit a few speed bumps, but its long-term growth potential remains intact.

Leo is a tech and consumer goods specialist who has covered the crossroads of Wall Street and Silicon Valley since 2012. His wheelhouse includes cloud, IoT, analytics, telecom, and gaming related businesses. Follow him on Twitter for more updates!

Amazon's (NASDAQ:AMZN) stock recently hit an all-time high as the COVID-19 crisis lit a fire under its e-commerce and cloud businesses. However, Mizuho analyst James Lee recently warned investors that Amazon's ad business would likely soften in the challenging macro environment.

Lee cut hits revenue growth forecast for Amazon's ad business from 40% to 28% for fiscal 2020, and he doesn't expect its growth to normalize until the first quarter of 2021. Lee claimed the decline would throttle Amazon's earnings growth for the next two years, and cut his EBITDA estimate for fiscal 2022 by 2.5%.

Lee slightly cut his price target for Amazon from $2,350 to $2,300 a share, but curiously maintained a Buy rating on the stock as it topped $2,400. Investors should always take analysts' ratings with a grain of salt, but should they be concerned about Amazon's ad business?

Let's dig deeper into this business, and I'll explain why it probably won't suffer as much as other ad platforms throughout the COVID-19 crisis.

Image source: Getty Images.

How does Amazon's ad business work?

Amazon's ad business sells digital ads across its e-commerce marketplace, hardware devices (including the Kindle, Fire TV, and Echo), and Amazon-owned sites like IMDb.com and DPReview.com. Amazon's third-party merchants can boost their sales with sponsored product placements, headline search ads, and product display ads. Advertisers can either use a self-serve ad platform or work with an Amazon account team to launch custom marketing campaigns.

First, 49% of shoppers in the U.S. start their product searches on Amazon, according to CivicScience, versus 22% on Google, 13% on other platforms, and 16% of users who rarely shop online. Since Amazon's users are ready to make purchases, they're more attractive targets for advertisers than Facebook users, who might simply be checking up on their friends, or Google users, who might be searching for other information.

Second, Amazon's massive e-commerce marketplace accumulates a treasure trove of data on users' shopping habits. That data is arguably more useful to advertisers than Facebook's social profiles or Google's search and browsing histories.

How fast is Amazon's ad business growing?

Amazon became the third-largest digital advertising platform in the U.S. after Google and Facebook in 2018, according to eMarketer. The firm estimates that Amazon's share of that market will grow from 7.6% in 2019 to 9.7% in 2021.

Amazon's ad business accounts for the bulk of its "other" business, which generated 5% of its revenue last quarter. Here's how quickly that unit grew over the past year.

Therefore, we can estimate that Amazon's total ad revenue rose roughly 39% in 2019. Facebook and Google's ad revenues rose just 27% and 16%, respectively, last year.

Will Amazon's ad business slow down?

Mizuho cut its estimates after an investor call with ad agency Tinuiti. The firm was also probably influenced by recent reports about Facebook cutting its ad rates to attract advertisers. However, it's also possible that Facebook is ceding advertisers to Amazon, which is experiencing a surge in e-commerce sales after the COVID-19 crisis forced shoppers to stay at home and brick-and-mortar stores to shut down.

Some advertisers will inevitably buy fewer ads from the major platforms, but Mizuho's claim that the slowdown will throttle Amazon's earnings growth into 2022 seems unreasonable. Amazon generates most of its profits from its cloud platform AWS (Amazon Web Services), and surging demand for cloud services throughout the lockdown period could easily boost the unit's profits and offset a slowdown at its smaller advertising business.

In short, Amazon's ad business might hit a few speed bumps in 2020, but it will likely keep gaining momentum against Facebook and Google. Meanwhile, Amazon's core e-commerce and cloud businesses will likely keep firing on all cylinders -- making it one of the strongest stocks in this volatile market.